Interest Rate Term Structure Decomposition at the Instrument Level

Abstract

The paper examines term structure decomposition at the instrument level – decomposing term structures for issues as well as the portfolio. Three different implementations are stipulated: axiomatic structural approaches, a sequential approach, and a base structure approach. The three different implementations are evaluated against a portfolio of risk-free government bonds. The goodness-of-fit and smoothness properties of instrument-level term structure decomposition are also considered. The conclusion points to remaining gaps in theory regarding instrument-level term structure decomposition, and considers areas of application – typically bond valuation.